You’ve invested a lot of time and money building your small business. You want to protect what you’ve created, especially if it’s your main source of income and your family depends on that small business.
By using a Massachusetts estate planning lawyer for your small business, you can protect assets from being unnecessarily taxed when you pass away, and you can control how and when your assets are distributed. You can provide your chosen beneficiaries with a strong foundation to continue the business.
Also, all businesses have some risk of legal exposure. Lawsuits could be brought on by customers, clients, suppliers, and other parties you contract with. A properly formed and well-maintained business entity can help defend you against civil litigation, and how your business is organized impacts how it’s treated, taxed, and administered after you pass away.
A sole proprietorship is an unincorporated business owned and run by one person with no distinction between the business and the owner. The assets for a sole proprietorship are the assets of the owner. When the owner passes away, the IRS lumps together the owner’s personal assets and business assets for federal estate tax purposes. This results in a larger amount of assets, which could potentially result in a higher amount of federal estate taxes.
An S-corporation is a type of corporation with 100 shareholders or less, and it has only one class of stock. It has the benefit of incorporation but is taxed as a partnership. The corporation may pass income directly to shareholders and avoid double taxation – income taxes being paid twice on the same source of income. Many small businesses and family-owned businesses are organized as S-Corporations because they provide families with corporate creditor protections devices and avoid double taxation.
However, owning share in an S-Corporation can result in unfavorable estate tax treatment. For example, say three siblings are the only shareholders within the family-owned and operated S-corporation. If one sibling dies personally holding S-corporation stock, the IRS will include the value of these shares in his taxable estate. The value of the deceased sibling’s shares should receive some valuation discounts because he held shares in a family-owned business, but the value of the asset will be included in his taxable estate. A bigger potential problem exists when only one person holds all of the shares in an S-corporation. The IRS will value the entire business and include its valuation in the departed’s taxable estate for estate tax purposes. Proper estate planning can reduce the IRS’s valuation of the S-Corporation thereby reducing the decedent’s taxable estate.
There are a number of tools available to small and family-owned business owners to achieve their estate planning goals. It’s important to talk to a skilled Massachusetts estate planning lawyer to help you put together the right plan for your small business. Examples of these tools include:
Family Limited Partnership (FLP)
A Family Limited Partnership (FLP) is a partnership among family members that allows joint ownership of family-owned assets. It’s commonly used as a real estate planning tool. FLPs have general and limited partners. Only general partners having managerial control. FLPs only protect limited partners from liability.
A few of the top benefits:
- It can reduce the taxable estate of older family members since they can transfer property to their children, thus shielding it from federal estate taxes.
- Since FLPs qualify for the gift tax exclusion, annual gifts can be made from the patriarch or matriarch to another family member and not incur a gift tax.
- It can also help protect assets from creditors.
Limited Liability Company (LLC)
This is the simplest way of structuring a business. It gives options for how the business is taxed and the number of owners it allows, but its best quality is its ability to limit personal liability if the business is sued or files for bankruptcy. LLCs can be taxed as partnerships, meaning the company’s income will be spread to each individual member’s taxes rather than taxing the company as a whole. LLCs allow all members to participate in managerial decision making, and they protect every member from liability.
Irrevocable Life Insurance Trusts (ILITs)
Many individuals get life insurance policies thinking that those policies are a great way to provide for their loved ones. However, what they might not know is that the proceeds of any life insurance policy will be included in their taxable estate upon their death if they retain ownership of the policy. An ILIT is one of several ways to avoid this pitfall, because the ILIT is considered a separate entity for tax purposes. An ILIT is a type of irrevocable trust that is specifically designed to hold and own life insurance policies. As such, all the proceeds from the life insurance policies owned by an ILIT will be allocated to the ILIT and not to the person who created the ILIT.
Personal Residence Trusts (PRTs)
The IRS will combine your business assets and personal assets upon your death when determining the value of your taxable estate. This includes the value of your personal residence, often one of the most valuable assets a person owns. Many married couples hold title in their homes in either joint tenancy or in a revocable trust. Both of these methods will prevent the property from being subject to probate administration, but won’t preclude the IRS from adding the deceased spouse’s interest in the property to their taxable estate. Personal Residence Trusts permit a person to irrevocably transfer their residence to the trust while reserving the right to live in the residence (rent free) for a number of years, after which the trust’s beneficiaries take title to the property. Additionally, there are special tax and mortgage rules related to PRTs, so it’s highly recommended to speak with a qualified Massachusetts estate planning lawyer.
Some assets can be jointly owned, so the asset automatically goes from one joint owner to the other upon one’s death. Moreover, in small and family-owned businesses, it’s advantageous to have more than one person authorized on business accounts so the business can continue operating after a family member passes away.
As with any estate plan, there are many factors to be weighed, and the tools that might be beneficial to one business/family may not necessarily be the right tools for you.
In addition to lowering your taxable estate and making lifetime gifts to your children, proper estate planning can also protect your assets from creditors. The easiest way to accomplish these goals is to make sure your business assets are separate from your personal assets. As a Massachusetts estate planning attorney who is skilled in this area, I can help you make the right choice for your situation. Call us today at 617.299.6976 or send an email to firstname.lastname@example.org to schedule a confidential, no-cost consultation.